Markets

Dividends on a Hot Streak

The tax cut has spurred more companies to boost their payouts. But are investors paying attention?

When Congress in May slashed the top federal tax rate on dividend income, Wall Street expected that more U.S. companies would be motivated to boost their cash payouts to shareholders.

A summer of fat dividend increases by some of the nation's biggest firms shows that wasn't just wishful thinking.

Despite concerns that corporate managers would prefer to hoard cash for stock buybacks, acquisitions or other purposes, a growing number of companies have been choosing to send more of their profit directly to their investors in the form of dividends.

Market research firm Standard & Poor's in New York said Wednesday that 418 firms raised their dividends in the third quarter, a jump of almost 40% from the same period in 2002 and up 85% from the third quarter of 2001.

"Clearly, companies are responding to the lower tax rate on dividend income," said Joseph Lisanti, editor of S&P's Outlook newsletter.

What isn't clear is whether investors are showing a new appreciation for dividends.

The stocks that have led the market's rally this year typically have been highly speculative issues that pay little or no dividend -- most technology shares, for example.

That has troubled some Wall Street pros, who fear that investors are replaying the late 1990s: shunning solid, dividend-paying companies in favor of chasing what could be short-lived highfliers.

"It's a return of wishful thinking" about unending capital gains, said Richard Bernstein, market strategist at Merrill Lynch & Co. in New York.

Yet some well-known firms that have raised their dividends significantly in recent months also have seen their stock prices rewarded.

Fast-food titan McDonald's Corp., for example, last week boosted its annual dividend payment 70%, to 40 cents a share, as part of an ongoing plan to reshape the company and its image with investors. The stock hit a 52-week high Wednesday, up 67 cents at $24.21.

Shares of financial services giant Citigroup Inc., which in July raised its annual dividend 75%, to $1.40 a share, are up 34% this year, double the rise of the S&P 500 stock index.

Home builder Lennar Corp., which last week said it would begin paying an annual dividend of $1 a share, a 1,900% increase from the token 5 cents a share it had been sending shareholders, saw its stock soar to a record high in Wednesday's market rally. The shares are up 75% this year.

Congress reduced the top tax rate on dividends from 38.6% to 15% -- the lowest since before World War II -- as part of a broader economic-stimulus package put forth by the Bush administration.

Many investors had lost interest in dividends over the last decade, in part because the tax code was biased against such income: Dividends were taxed as ordinary income, while long-term capital gains were taxed at far lower rates.

With the latest tax cut, dividends and capital gains now are taxed at the same rate.

In theory, that is supposed to make dividend income more attractive to investors, because dividends generally represent a return that investors can count on each year. Capital gains, by contrast, are unpredictable.

Companies tend to decide on dividend payment rates with great care, and are loath to cut their payouts once established.

But even as dividend payments rise this year -- companies in the blue-chip S&P 500 index are on track to boost their payments 10.2%, on average, the biggest increase in more than a decade -- the percentage dividend yield on most stocks is in the low single digits.

That may be one reason why many investors can't get excited about dividends, experts say.

The annualized dividend yield on the S&P 500 index is 1.6%. In the 1970s and 1980s, blue-chip yields typically were 4% to 6%. (The yield is calculated by dividing the dividend by the stock's price.)

Still, the dividend yields on many big-name stocks are far above the 0.5% or so that investors are earning on money market funds and bank savings.

What's more, though dividend yields are historically low, they could be crucial in providing investors with decent "total" returns on stocks in the next few years if economic growth is moderate and share price gains slow from this year's heady pace.

That would be important even for investors who own stocks in tax-sheltered accounts.

The concept of total return, meaning the combination of dividend income and capital appreciation, was important to investors for most of the last century -- until the unprecedented boom in stock prices in the late 1990s.

Some experts say that one long-term benefit of higher dividend payments is that capital should be allocated more efficiently in the economy, because investors would have more say in where profits are put to work.

That would leave less to be "frittered away on dumb ideas" by corporate executives, said Robert Arnott, head of money management firm First Quadrant in Pasadena.

But analysts also note that some investors may be suspicious about whether the lower tax rate on dividend income will be long-lasting.

If President Bush is defeated in 2004, a Democratic successor could argue that the dividend-tax cut was a sop to the wealthy, and seek to take it away, said economist Don Straszheim of Straszheim Global Advisors Inc. in Santa Monica.

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Dividends on the rise

A sampling of companies that have raised their dividend payments substantially this year: